Will we be spenders or savers? It is a big question for the economy. Without a rise in consumer spending it is hard to get economic growth. It is also a big question for retailers and other businesses relying on consumer demand.
The evidence on what has been happening so far is mixed. Official figures suggest that retail spending has held up better than many other parts of the economy, with a 2.1% rise in sales volume last month compared with a year earlier.
The British Retail Consortium said sales value was down 0.1% over the year on a “like-for-like” basis, though total sales (unadjusted for new store openings) were up 2.2%. The BRC is downbeat, particularly about non-food sales.
It is outside retailing, however, that consumers have been cutting back most. Official figures for overall consumer spending show a 3.4% drop in the second quarter against the corresponding period of 2008, one of the sharpest falls on record.
Non-retail spending, such as that on cars, restaurant meals and consumer services, has clearly been very weak, though the Bank of England, in its monthly minutes last week, suggested the most recent consumer data could be revised higher. Even so, there are hints from retailers of other potential problems. Relative to income, young people are the nation’s big spenders. One generally successful retailer, JD Sports, which owns the Bank and Scotts fashion chains, said sales in recent weeks had dipped, possibly as a result of a rise in unemployment among 18-24 year olds. The rate for that age group is now 17.5%.
Unemployment is one potential constraint on spending. The bigger question is whether the combination of tighter credit, a rise in the saving ratio, and tax hikes will strangle any consumer recovery at birth.
Let me start with household debt. This time last year it stopped rising. Outstanding lending to households, £1,457 billion at the end of July, is fractionally lower than in September last year.
Some of this is due to deliberate decisions to repay debt. Mostly it is happening because the supply of new lending is less than the flow of redemptions. The fall in house prices, before their recent small recovery, also stemmed the rise in debt.
Household debt is overwhelmingly — well over 80% — in mortgages, and Britain has high owner-occupation. There is a natural tendency for mortgage debt to rise because new entrants to the housing market have more debt than those leaving, who have usually paid off their loans years ago. That effect has been halted in the past year by limited mortgage availability.
To what extent will people be driven by a desire to pay down debt? Kate Barker, a member of the Bank of England’s monetary policy committee, said in a speech last week that it was not clear before the crisis that, except for a tiny minority, household debt levels were unsustainable.
Spencer Dale, her MPC colleague and the Bank’s chief economist, made the very good point that, while household debt rose substantially in the years leading up to the crisis, so did financial assets owned by households. A kind of conveyor belt operated. As he put it: “The money borrowed by young families ended up in the bank accounts of older households.”
Most of that money was not spent — consumer spending did not rise as a proportion of gross domestic product — but invested. There was a 10-year rise of £1,000 billion in debt alongside a £750 billion increase in household financial assets.
People may change their views on how much debt they want to carry as a result of the crisis, and it is no bad thing that the overall amount has levelled off. It will fall for a while in relation to income. But a healthy scepticism is in order about this.
The vast majority of borrowers had their mortgages in place before the crisis, and the advent of a 0.5% Bank rate. The gradual return to a semblance of interest-rate normality, probably starting next year, is not going to result in a scramble to deleverage. They can leave that to the banks.
What about a related aspect of this, the saving ratio? Previous recessions have seen reductions in the growth of borrowing and a rise in saving. In the recessions of the early 1980s and early 1990s, the saving ratio hit 12% of household disposable income.
The saving ratio in the first quarter was 3%, down from 4% in the final quarter of 2008. Figures this week should show a second-quarter rise. If it were to hit 12%, consumer spending would indeed suffer.
Many people think that Britain’s low saving ratio reflects our modern-day, plasma-screen, get rich quick society. If only we were as prudent as, say, in the 1950s, before the credit card era, when it was safe to leave your door unlocked at night.
In the 1950s, however, the saving ratio was zero, on average. It normally rises at times of economic distress and high unemployment. In both previous recessions, it peaked close to the economy’s low point. If it were going to rise sharply, therefore, it probably should have done so by now.
One reason it has not is staring us in the face. Household saving reflects the interaction between borrowing and saving, and includes a large element which is out of people’s hands, such as contributions by firms to pension schemes.
To the extent that it does reflect decisions by individuals, though, there has not been much incentive to save of late. The Bank, in another contribution to the spending-saving debate in its latest quarterly bulletin, out last week, noted “the substantial stimulus provided by monetary policy” had cushioned the rise in saving. A Bank rate of 0.5% will not bring out the inner squirrel in anybody. Policy has been aimed at dampening down the saving ratio rise.
So we should not exaggerate the likely effect of debt aversion or saving on spending. Taxes may be a different matter, but that depends on how draconian the next government intends to be.
The past, as always, may be the best guide to the future. After the recession of the early 1990s, taxes were raised over a number of years. There was a housing and debt hangover.
Yes, consumer spending growth averaged 2.75% a year over the first four full years of recovery. Nobody would be too upset, or surprised, if it were a bit weaker than that over the next four years. Beyond that, however, don’t expect a new age of austerity. Britain’s consumers may be down, but they are certainly not out.
Originally published at David Smith’s EconomicsUK and reproduced here with the author’s permission.